Greece is the time, is the place, is the motion.

Currency in Crisis

The US dollar is again being broadly supported by heightened concern that Greece’s debt/deficit issues are soon to reach a climax. The pressure on Greece is more clearly spilling over to the other Mediterranean countries. The yen too has generally benefited from these same development, despite an unexpected and large drop in manufacturing orders (-5.4% vs +3.7% consensus). Sterling slipped in line with the euro even though the 1% rise in Feb industrial production was twice what was expected as was the March Halifax house price index (+1.1% vs consensus 0.5%). Emerging market currencies are also generally lower. As expected the BOE left policy unchanged. The ECB is not expected to alter policy either, but the focus is on the new collateral framework and the sliding haircuts, for which Trichet promised more details.

Greece is the time, is the place, is the motion. It remains the key force in the capital markets. There is increasing concern that Greece needs to resort to the unspecified facility agreed to by the EU and IMF in late March. While Greek officials try to reassure the market that April funding needs have already been met, the loss of confidence among investors means that the issue is coming to a head sooner. The news stream is not good. Moody’s cut the outlook to two Greek banks today to negative form stable, and this is on top of the downgrades to 5 commercial banks last week. This comes on the heels of yesterday’s report that Greek banks want to tap into support package put together in 208 by the previous government. There have been anecdotal reports of household and commercial depositors withdrawing funds from Greek banks. The government reported today households and businesses withdrew 8.5 bln euros of deposits in Jan-Feb period, which is roughly 3% of the total deposits.

The strategic ambiguity of the interest rate and conditions that will be attached to access to EU/IMF funds continues to raise the prospects of a Greek default. As has been well discussed, more than 2/3 of Greek bonds are in non-resident hands and largely held by other European banks. The risk of financial and economic contagion is real is being recognized by investors.

Greek bonds continue to sell-off and there is clearly heightened contagion today. For the record Greek’s 10-year yield of about 7.48% today is about 439 bp on top of Germany. Portugal’s 10-year yield is 10 bp higher and the premium over Germany is the widest since early Feb. Spanish, Irish and Italian bonds are under somewhat less pressure, but are generally under-performing. The flight to safety has seen 2-year German bunds yields slip to a record low. The US Treasury sells 30-year bonds today. The auctions this week have generally been well received and sufficiently so as to negate some of the concerns that arose in late March due to the more tepid reception.

The New York Times reports that China could adjust its currency in the coming days. The market does suspect something is afoot. Note that within days of postponing the Treasury’s assessment of currency market manipulation, Geithner, who was visiting India, was invited to Beijing. The 12-month NDFS are edging higher and are now near 3%. If China does not want to give the appearance of capitulating to US pressure, it seems that expectations for an imminent announcement may be misplaced. In any event, if and when China moves, we expect a small move that would be largely inconsequential for trade and capital flows and, given the US-Japanese experience, is likely to prove insufficient for some in the US (and Europe).